Macroeconomics

F I G U R E  

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Shifts in Aggregate Demand

For a given price level, national

income fluctuates because of

shifts in the aggregate demand

curve. The IS–LM model takes the

price level as given and shows

what causes income to change.

The model therefore shows what

causes aggregate demand to

shift.

Price level, P

Income, output, Y

Y

1

Y

2

Y

3

AD

1

AD

2

AD

3

Fixed

price

level

(SRAS)

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The two parts of the IS –LM model are, not surprisingly, the IS curve and the

LM curve.

IS stands for “investment’’ and “saving,’’ and the IS curve represents

what’s going on in the market for goods and services (which we first discussed

in Chapter 3). LM stands for “liquidity’’ and “money,’’ and the LM curve repre-

sents what’s happening to the supply and demand for money (which we first dis-

cussed in Chapter 4). Because the interest rate influences both investment and

money demand, it is the variable that links the two halves of the IS –LM model.

The model shows how interactions between the goods and money markets

determine the position and slope of the aggregate demand curve and, therefore,

the level of national income in the short run.

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